A Conversation With Allied Capital's CEO

William L. Walton, chief executive of Allied Capital, a District-based business development company, has been around long enough not to be rattled by a momentary market swoon. He spoke recently with Washington Post staff writer Thomas Heath and shared his views on the latest market turmoil.

Heath had phoned Walton to ask him how he is sleeping at night, given the recent turbulence in the stock and credit markets. As Walton spoke to The Post on the telephone, he glanced at the latest market figures on his computer screen and bemoaned that "everything was red."

But, despite his chagrin, the market upheaval hasn't rattled Walton, who has lived through several boom-and-bust cycles during his 30 years in the financial services business. Walton, 57, got his start as a commercial banker in Chicago in 1977, in the midst of weak economy and a bear market. He saw stretches during which the prime lending rate rose to as high as 18 percent. (For perspective, the prime rate is now at 8.25 percent.)

Here are excerpts from that telephone interview in which Walton discussed the markets and the economy:

"I have been investing and lending to middle-market companies through the last 30 years. I have worked investing in and lending to hundreds of companies in my career. And I'm fundamentally bullish on the American economy, but I do think we are going to go through one of our inevitable cyclical adjustments. This could be the beginning of it.

"Whether this is a correction or a full fledged bear market depends on how much of this turmoil in capital markets spills into the real economy. The concern is the backup in the mortgage market will effect consumer spending. And moreover a longer term correction in the equity markets would affect consumer spending because household net worth would drop.

"We haven't had a consumer recession in 17 years. And the consumer will bear the brunt of an increase in oil price, higher gas prices. The wealth effect that comes from lower priced homes and the decline in public market equity values will make people feel less rich, and so they will spend less.

"We are already seeing that at Wal-Mart. I think Wal-Mart has a higher percentage of subprime mortgage market customers than other retailers. People are having trouble making their paychecks last until the end of the month, and that's troubling. This has been a consumer driven economy for the last couple of decades. The consumer was not affected that much by the 2001 downturn. That was business a business investment-driven downturn. The consumer tore right through that.

"The Washington economy is, as usual, in great shape because the diversified economy and because the fairly substantial growth in federal spending that stays in the Washington metro market. The only real soft spots I see are the markets for residential home building, some of which has been speculative in the far suburbs. So there might be some problem there. Otherwise, I think the local economy is in fairly good shape.

"Moving away from Washington, we have got to look at the fact that debt as a percentage of [gross domestic product] has risen in the last decade. Its now about 3.5 times GDP, which is significantly higher than it was just five years ago. As the debt markets contract, it will have an impact on the economy.

"Psychology is critical both in the capital markets and in the real economy. And if people start feeling pessimistic, they slow their spending. And if they slow their spending, they buy less. Companies cut back. Companies invest less in plant and equipment. Companies cut back on hiring. Unemployment goes up. Tax revenue goes down. And the impulse is raise taxes, which is bad for the economy.

"We have never seen capital markets with such high leverage, such complex financial instruments and huge new international markets. You find Germans investing in U.S. subprime loans, and that's new.

"We have enjoyed rising asset value in all markets the last five years. By that I mean equities, debt, commodities, real estate and collectibles. All the major assets have been in bull market the last five years, so I think some sort of correction is inevitable. Short-term, I think we are going to see some real impact from the capital markets correction.

"But medium and long-term, I think the fundamentals for the worldwide economy are quite good."